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While it appeared heresy to the market only a few months ago, talk of the Fed tapering its asset purchases is absolutely kosher these days. Indeed, the FOMC is expected to announce a $10 billion reduction in the monthly pace of its quantitative easing purchases, or QE, to which risk assets could react positively. Interestingly, though, the Fed’s decision to taper comes amid mixed economic data and tightening financial conditions, particularly in the mortgage market, meaning Chairman Ben Bernanke & Co. could be putting further pressure on homeowners and harm one of the pillars of the recent recovery.

The major policy decision of the past several years also comes as the Fed leadership is in a moment of transition as Bernanke’s term is set to expire in early 2014, with Janet Yellen as the frontrunner after Larry Summers dropped out amid intense political pressure. President Obama is expected to nominate Yellen soon after Thursday’s FOMC meeting, yet another potential contender for the Chairmanship, Don Kohn, could surprise markets.

The Bernanke Fed is expected to cut back on its purchases by $10 billion to a monthly rate of $75 billion, experts at Goldman Sachs and Nomura agree. Beyond introducing the so-called soft taper, which Nomura suggests will consist entirely of U.S. Treasuries given rising mortgage rates, the FOMC is expected to revise its forward guidance in order to further demarcate the boundary between tapering and monetary tightening; this could include lowering the Fed’s unemployment threshold for the first rate hike or giving further details as to what it plans to do when jobless falls below the current 6.5% benchmark.

Trying to give closure to his oeuvre, Chairman Bernanke indicated he would like to begin to wind down the Fed’s asset purchase program as the beginning of the exit strategy is set into motion. QE has helped stock markets hit historic highs while supporting a housing recovery and, according to the Fed, pushed down the unemployment rate as yields were kept at record lows. Yet, as hedge fund billionaire David Tepper put it, equities could hit a bubbly overdrive if the Fed doesn’t stop expanding his balance sheet.

A coming end to QE caused turbulent markets and an intense rise in interest rates which has tightened monetary conditions, according to Goldman’s economic research team. In the three months since the June FOMC meeting where tapering was formally introduced, the yield on 10-year Treasuries has jumped more than 70 basis points, increasing “by a greater amount than during the entire previous interest rate tightening cycle between June 2005 and June 2006,” Tradeweb’s analysts explained.

This tightening hit homeowners where it hurt. Goldman’s data showed that as rates on 30-year fixed mortgages rose 1.2 percentage points since May, the monthly mortgage payment for a median-priced home with a 20% down payment rose by $110. “The Fed is particularly sensitive to the rise in mortgage rates given the special effort it has devoted to supporting the housing market through its credit easing policies (MBS purchases),” explained Goldman’s team, while Nomura’s researchers expect tapering to consist entirely of Treasuries. During that time, shares in major homebuilders like KB Home and LennarLennar took a dramatic tumble.

Inflation has remained under control, giving the Fed more room to maneuver, but the market has definitely tightened as it equated tapering to rate hikes. According to Goldman, expectations for the first rate hike were pushed forward one quarter to Q1 2015, at one point dipping as far as late-2014, giving added importance to the Chairman’s explanation of what is to come in terms of policy decisions.

The issue of who will succeed Chairman Ben Bernanke then becomes increasingly relevant. A few months ago, President Obama indicated the Fed Chairman was on his way out, fueling speculation that initially pointed to Vice Chairwoman Janet Yellen, a staunch supporter of Bernanke’s policies. Yet Larry Summers’ name was floated by the press, and Obama, leading to an intense political backlash which ultimately pushed Summers out of the race. Nomura’s research team suggests there’s a two-in-three chance Yellen will get the nomination, but the President had indicated former Vice Chairman Don Kohn was also a possible candidate. Markets rallied on Monday as Summers, seen as less of a supporter of monetary stimulus, dropped off, while gold remained flat and major financials like CitigroupCitigroup and Bank of AmericaBank of America gained.

Yellen guarantees continuity, as she’s been at Bernanke’s side all along, and has made it very clear she supports similar policies. Kohn, who was replaced by Yellen, is a bit more of a stranger to market participants. A recent profile by Andrew Ross Sorkin for Dealbook suggests his views have evolved, from supporting QE to currently warning of the risks of excessive balance sheet expansion. It remains to be seen what kind of a reaction Kohn would receive from the market.

Whatever angle one takes, Thursday’s FOMC meeting, and ensuing press conference, will help set the stage for the next phase of monetary policy in the U.S. Whether Bernanke, or President Obama, can give the market the certainty it wants, remains an unanswered question.

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